It has been known for some time now that India's banking system is burdened with a huge volume of non-performing assets (NPAs), or loans on which borrowers have defaulted on interest and amortization of payments. What is noteworthy is that much of the NPA burden was accumulated during the years of reform. According to one estimate, NPAs in India's banks rose from Rs 37,500 crore at the end of financial year 1991–92 to Rs 1,10,000 crore at the end of 2001–02. Given their importance within the banking system, the public sector banks were major contributors to NPAs in the system. At the end of financial year 2002, the accumulated NPAs of twenty-seven public sector banks totalled Rs 56,000 crore.

The distribution of these NPAs was skewed in favour of big borrowers, since large borrowers with 11,000 individual accounts accounted for as much as Rs 40,000 crore of total bad debt. Among public sector banks too high-value defaults involving 1,741 accounts over Rs 5 crore amounted to Rs 22,866 crore or 40 per cent of the total. Though this concentration of bad debt among large borrowers should have made recovery easier, the actual record of recovery has been extremely poor. An assessment conducted by the All India Bank Officers' Association (AIBOA) in December 2002 indicated that less than Rs 5,000 crore of bad debt had been recovered during the preceding eight years.

This record of poor recovery came to light when the NPA burden of the banking system was receiving considerable attention, since as part of the ongoing financial reform process banks were required to deal with their NPA legacy and set right their books in order to meet more stringent capital adequacy norms and rules of accounting. Bad debts were being used to pillory the public sector banks and justify privatization, though large private players with payment defaults were responsible for the state of the banks and it was clear that privatization would be feasible only if these liabilities were dealt with or written off altogether.

Among the many routes that were pursued to deal with the accumulating bad debt legacy, there were some that received special attention. The first and most obvious route was to restructure existing loans so as to reduce the burden of payments and extend the deadline faced by borrowers so that they could revive themselves. Such restructuring involves some temporary sacrifice on the part of the banks aimed at encouraging revival of the afflicted unit. According to one estimate, by the end of March 2002 banks had restructured assets to the tune of Rs 7,000 crore.

The second was to set aside potential profits as provisions for bad assets. Banks have only gone part of the way in this direction. The cumulative provisions against loan losses of the public sector banks worked out to 42.5 per cent of the gross NPAs for the year that ended on 31 March 2002 while international norms are as high as 140 per cent.

The third was infusion of capital by the government into the public sector banks. It is estimated that the government had already injected a massive Rs 20,446 crore towards recapitalization of public sector banks (PSBs) till end-March 1999 to help them fulfil the new capital adequacy norms. More recently the S.P. Talwar and Verma committees set up by the finance ministry had recommended a two-stage capitalization for three weak banks (Indian Bank, United Bank of India and United Commercial Bank) involving infusion of a total of Rs 2,300 crore for shoring up their capital adequacy ratios. Similar infusion arrangements have been underway in the case of financial institutions like the IDBI and IFCI and in bailing out of UTI, involving large sums of tax-payers' money.

Finally, there are efforts to retrieve as much of these assets as possible from defaulting clients, either by directly attaching the borrowers' assets and liquidating them to recover dues or by transferring NPAs to specialized asset reconstruction or asset management companies. The government tried to facilitate recovery through this route with an ordinance issued in June 2002, which was subsequently replaced by the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Bill passed in November 2002.

The Ordinance and the Bill were aimed at restructuring the framework of debt workouts in favour of lenders and against the borrowers. Prior to the introduction of the ordinance and passage of the Bill the legal framework was biased against efforts by lenders to enforce contracts and recover legitimate dues. Further, the ability of companies to use the provisions of the Sick Industrial Companies Act 1985 (SICA) and the option to turn to the Board for Industrial and Financial Reconstruction (BIFR), helped them keep lenders at bay despite default. SICA provides that all other litigation against companies whose cases are being considered by the board would cease pending a settlement, encouraging defaulting companies to approach the BIFR to sidestep creditors.

The Ordinance and the Bill enable secured creditors to issue, without the intervention of any court or tribunal, a 60-day notice requesting settlement of dues. If the borrower does not comply the secured creditor can resort to any one or a combination of the following: (i) take possession of the secured assets of the borrower, including the right to transfer by way of lease, assignment or sale for realizing the secured asset; (ii) appoint any person to manage the secured asset; and (iii) require at any time by notice in writing, from any person who has acquired any of the secured assets from the borrower and from whom any money is due or may become due to the borrower, to pay the secured creditor, as much as the amount that is sufficient to pay the secured debt. All that is required is that creditors accounting for 75 per cent or more of the secured lending should agree to initiate recovery proceedings.

While the borrowers are allowed to seek protection from secured creditors by filing an appeal to the Debt Recovery Tribunals (DRTs), they will also be required to deposit with the tribunal 75 per cent of the amount claimed by the creditors in order to prevent misuse of appeal provisions. The DRTs can, at its discretion, reduce the deposit amount, but only after citing its reasons for doing so. Even the BIFR route does not provide much protection to borrowers since the Bill allows lenders to seek abatement of cases pending before the BIFR so that they can proceed with action against default as specified in the Bill. The importance of this provision can be gauged from the fact that high-value non-performing assets (those above Rs 5 crore) accumulated with firms, involved in 603 cases pending at the board, amounted to Rs 8,163 crore as on 31 March 2002, while another Rs 1,905 crore were locked up in cases where rehabilitation was in progress.

One issue that remained even after providing lenders with these sweeping powers was the modalities concerning the management of the secured assets, since the banks may not have the competence or resources to either liquidate or manage these assets. The Securitization Bill provides an answer to this as well. It provides for the creation of asset reconstruction/management companies, to whom creditors can transfer their assets either in return for securities carrying terms mutually agreed upon or for an appropriate fee in order to realize dues in part or in full. The assets reconstruction/management company can take on responsibility for the management of the business of the borrower, by intervening in the management of the borrower's business; can sell or lease a part or whole of the business of the borrower; reschedule the payment of debts payable by the borrower; and settle dues payable by the borrower. It can also act as a mere agent for any bank or financial institution for the purposes of recovering their dues from the borrower or for managing the secured assets.

The RBI and the banks clearly saw the Bill as a threat to force habitual defaulters to behave. This was obvious from the fact that the RBI introduced for short periods of time a 'one-time settlement (OTS) system' aimed at giving defaulters a negotiated way out of the trap. Under the OTS defaulters, with debt up to Rs 5 crore initially and Rs 10 crore more recently, were encouraged to enter into discussions with the banks for ways to deal with their debts in default. While this offer was pending, the banks sent out recovery notices to a large number of debtors to pressurize them into engaging in discussions with the banks.

It should be obvious that of the above ways to deal with the legacy of NPAs, the first three are means to let off defaulting borrowers easily or completely. They were either being given time to deal with a reduced-payment burden or the cost of default was being borne partly or wholly by the banks themselves or by the government. It was only the fourth, involving a change in the legal framework governing the relations between lenders and borrowers, which involved penalties on the defaulting borrowers.

However, it is here that the progress has been slow. By September last year out of the total high-value defaults of Rs 22, 866 crore with twenty-seven public sector banks, the banks had filed recovery suits only in 816 cases involving total NPAs of Rs 10,657 crore. There were 586 cases pending before the Board for Industrial and Financial Reconstruction (BIFR) with total bad assets of Rs 8,163 crore. The possibility of using the new provision to withdraw these cases from the BIFR was only being contemplated. Besides this, 114 cases were under rehabilitation involving Rs 1,905 crore, while negotiations for settlement were being held in 157 cases involving Rs 2,769 crore. The banks were also still considering action in the remaining 236 accounts involving NPAs of Rs 2,847 crore. The figures relating to the accounts in which suits had been filed include a few cases pending before BIFR since reference to the board was made after filing of the suit.

Because of the unwillingness of banks to exercise their new powers, the results have indeed been poor. Speaking at a National Conference on Economic Legislations organized by the Federation of Indian Chambers of Commerce and Industry (FICCI) at the end of February 2003 , Arun Jaitley, Union Minister for Law, Justice, Commerce and Industry declared that financial institutions and banks had been able to recover only 5 per cent of their bad debts. Clearly there are strong forces at work preventing the banks from using the sweeping powers that the Securitisation Bill gives them to quickly clear a large proportion of their accumulated NPAs. In fact, industry associations and big business spokesmen have been criticizing the Bill on the grounds that it does not distinguish between 'wilful defaulters' and 'honest failures'. The implication obviously is that not only should big business in India be provided large doses of credit to create and manage its risk-taking ventures, it should also be insulated against all risks in the name of 'honest failure', and should be penalized only in the case of wilful default amounting to fraud. Needless to say, the next step would be to identify every case of possible wilful default as an honest failure.

Clearly, the message that has gone out to the private sector is that the new powers with which the banks have been armed would not be used across the board. This is clear from the response to the revised OTS scheme announced by the RBI on 29 January in which the ceiling on the size of accounts eligible for the scheme was raised to Rs 10 crore and defaulters were expected to enter into negotiations with the relevant banks by 30 April. However, unlike the earlier scheme relating to accounts up to Rs 5 crore, the response in this instance has reportedly been poor. Rather than launch proceedings, it appears the government has decided to extend the scheme for a few more months. Thus, in practice defaulters on debt to India's banking system, which is being forced to restructure and recapitalize, still receive kid-glove treatment. It is not surprising therefore that little progress has been made in redressing the huge NPA-problem that confronts the banking system of India today.